JPMorgan CIO Swaps Pricing Said to Differ From Bank

The JPMorgan Chase & Co. (JPM) unit
responsible for at least $2 billion in losses on credit
derivatives was valuing some of its trades at prices that
differed from those of its investment bank, according to people
familiar with the matter.

The discrepancy between prices used by the chief investment
office and JPMorgan’s credit-swaps dealer, the biggest in the
U.S., may have obscured by hundreds of millions of dollars the
magnitude of the loss before it was disclosed May 10, said one
of the people, who asked not to be identified because they
aren’t authorized to discuss the matter.

“I’ve never run into anything like that,” said Sanford C.
Bernstein & Co.’s Brad Hintz in New York, ranked by
Institutional Investor magazine as the top analyst covering
brokerage firms. “That’s why you have a centralized accounting
group that’s comparing marks” between different parts of the
bank “to make sure you don’t have any outliers,” said the
former chief financial officer of Lehman Brothers Holdings Inc.

The biggest U.S. bank by assets is facing regulatory
scrutiny and criminal probes over losses in the CIO, which Chief
Executive Officer Jamie Dimon pushed in recent years to make
bigger and riskier bets with the bank’s money. The loss, which
Dimon said stemmed from positions that were “poorly
monitored,” prompted calls from Congress for tighter bank
regulation and triggered criminal investigations by the U.S.
Department of Justice and Federal Bureau of Investigation.

Credit Tranches

Jennifer Zuccarelli, a spokeswoman for New York-based
JPMorgan, declined to comment on whether the CIO and investment
bank were using different prices.

“All components of the synthetic credit portfolio in the
chief investment office were mark-to-market,” she said.

The trades in question, made by a CIO group that included
Bruno Iksil, nicknamed the London Whale because his positions
grew so large, were on so-called tranches of credit-swap
indexes, the people said.

Tranches allow investors to wager on varying degrees of
risk among a pool of companies. Credit swaps pay the buyer face
value if a borrower fails to meet its obligations, less the
value of the defaulted debt.

Because JPMorgan had amassed such large positions, even a
small change in how the prices were marked may have generated a
big difference in the value of the trades, one of the people
said.

Not ‘Normal’

“It would not be normal to book it at levels that were
better than the dealer desk,” said Peter Tchir, founder of New
York-based hedge fund TF Market Advisors. “That would strike me
as a very big issue.”

Bloomberg News first reported April 5 that Iksil had built
positions that were so large he was driving price moves in the
$10 trillion market for credit-swap indexes. About a week later,
on a conference call to announce quarterly results, Dimon, 56,
called news about the trades a “complete tempest in a teapot.”

On the May 10 conference call briefing analysts on the $2
billion trading loss, Dimon said the trades, which he said
initially had been a hedge against the bank’s credit exposure,
turned out to be “riskier, more volatile and less effective as
an economic hedge than we thought.”

“We were reducing that hedge,” he said. “But in
hindsight, the new strategy was flawed, complex, poorly
reviewed, poorly executed and poorly monitored.”

Dimon said on the call the CIO, with more than $300 billion
in its investment portfolio, had unrealized gains of $8 billion
at the end of March.

VaR ‘Inadequate’

Dimon also said on the call that the bank changed how it
calculates the CIO unit’s so-called value at risk, or VaR, a
measure of how much the company estimates it could lose on
securities on 95 percent of days.

The bank increased its VaR for the first quarter,
previously disclosed at $67 million, to $129 million. JPMorgan
used a new model for calculating its trading risk in the first
quarter that Dimon said was “inadequate.” The bank didn’t
disclose any change to its model for the investment bank.

The U.S. Securities and Exchange Commission is reviewing
the accuracy and timing of JPMorgan’s disclosure of those
changes, Chairman Mary Schapiro said May 22 before the Senate
Banking Committee in Washington. The bank changed its VaR model
for the chief investment office during the first quarter without
telling investors.

Dimon has agreed to testify June 13 before the Senate
committee in a hearing on the trading loss, Sean Oblack, a
spokesman for the panel, said today in an e-mailed statement.

The net amount of credit-swaps protection sold by JPMorgan
soared eight-fold to $97.4 billion in the three months ended
March 31, Federal Reserve data show. The bank held total credit
swaps contracts on $6.05 trillion, the biggest among the six-
largest U.S. bank holding companies, the data show.